Discount Rate (Pension)
The interest rate used to calculate the present value of future pension liabilities. A lower discount rate produces higher liabilities; a higher rate produces lower liabilities.
How It Works
The discount rate is the most consequential and contested assumption in pension accounting. Public pension plans typically use their assumed investment return (6.5-7.5%) as the discount rate. Financial economists argue that since pension benefits are guaranteed obligations, they should be discounted at a risk-free rate (3-4%), which would roughly double reported unfunded liabilities. The choice of discount rate is the single biggest reason that different analyses produce wildly different estimates of pension health.
Related Terms
- Actuarial Assumption — The financial and demographic projections used to calculate pension costs and liabilities — including expected investment returns, employee life expectancy, and salary growth.
- Funded Ratio — The percentage of a pension plan's projected liabilities that are covered by current assets. A plan with $80 in assets for every $100 in liabilities has an 80% funded ratio.
- Unfunded Liability — The difference between a pension plan's projected liabilities (what it owes to current and future retirees) and its current assets. Also called the unfunded actuarial accrued liability (UAAL).
About This Definition
This definition is part of the CitySpend Municipal Finance Glossary — 59 terms explaining how city governments fund and manage public services. All definitions are written in plain language for taxpayers, journalists, students, and municipal bond investors.